Aug
11
2023
What Are Exotic Options? 11 Types of Exotic Options

What Are Exotic Options? 11 Types of Exotic Options

By | Growing Wealth, invest, Investing | Comments Off on What Are Exotic Options? 11 Types of Exotic Options

An option is a financial instrument that gives the buyer the right to purchase or sell an underlying security, such as a stock, during a set time period for an agreed-upon price. They are popular with investors because they allow the investor to bet on the price increase or decrease of a stock, without owning the stock itself.

Exotic options are a class of options that allow investors to take advantage of some features of options contracts to pursue other strategies. Exotic options pricing tends to be higher than that of traditional options.

What Is an Exotic Option?

Exotic options are hybrid securities that offer unique and often customizable payment structures, expiration dates, and strike prices. For those features, they typically charge a higher price than traditional options. University of California Berkeley professor Mark Rubenstein coined the term “Exotic Options” in a 1990 paper about contracts.

The asset that underlies these options also includes non-traditional assets and securities. Exotic options can be either covered or naked call, meaning that the seller has not set aside shares or cash to meet the obligation when it expires.

To understand what makes an exotic option exotic, let’s review a traditional, plain-vanilla options contract and how it works. With a traditional option, the owner can buy or sell the underlying security for an agreed-upon price either before or at the option’s predetermined expiration date. The holder is not, however, obligated to exercise the option, hence the name.

An exotic option typically has all of those features, but with complex variations in the times when the option can be exercised, as well as in the ways investors calculate the payoff.

Investors typically buy and sell options in the over-the-counter (OTC) market, a smaller dealer-broker network. An exotic option may have underlying assets that differ from those offered by traditional options. Those underlying assets can include commodities like oil, corn and natural gas, in addition to stocks, bonds, and foreign currencies.

There are even exotic derivatives that allow traders to bet on things like the weather. Both institutional and sophisticated retail investors use customized exotic options to match their own unique risk-management needs.


💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

11 Types of Exotic Options

There are many types of exotic options that investors can purchase for exotic options trading. Here’s a look at some of them:

1. Asian Options

One of the most common forms of exotic options contract, the Asian option is a contract whose payoff to the holder reflects on the security’s average price over one or several agreed-upon periods of time. This makes it different from a U.S. option, whose return reflects the price of the underlying asset when the holder chooses to exercise it, and different from a European option, whose payoff reflects the price of the security at the time of the option’s expiration.

2. Barrier Options

These options remain effectively dormant until activated, usually by the price of the underlying asset reaching a certain level.

3. Basket Options

Unlike traditional options, which typically have a single underlying asset, basket options contracts depend on the price movements of more than one underlying asset. For holders, the payout on a basket option reflects the weighted average of the assets underlying the contract.

4. Bermuda Options

The main differentiator of Bermuda options is when the holder can exercise them. An investor can exercise a Bermuda option at its expiration date, and at a handful of set dates before then. This makes them different from U.S. options, which holders can exercise at any point during the contract, and European options, which can only be exercised at expiration.

5. Binary Options

Sometimes called digital options, binary options are unique because they only guarantee a payout to the holder if a predetermined event occurs. This all-or-nothing investment typically delivers a predetermined payout or asset if the agreed-upon event occurs.

6. Chooser Options

With ordinary options contracts, the investor must decide upfront if they’re buying a call (right to buy the underlying security) or put (right to sell the underlying security) option. But with a chooser option, the holder can decide whether they want the option to be a put or call option at a predetermined date between when they buy the chooser option and when the contract expires.

7. Compound Options

These options, often called split-fee options, allow investors to buy an option on an option. Whether or not a compound option pays off depends on whether or not another option pays off. Investors in compound options have to make their decisions based on the expiration dates and strike prices of both the underlying option, as well as the compound option itself.

8. Extendible Options

The main advantage that extendible options offer is that they give an investor the ability to postpone the expiration date of the contract for an agreed-upon period of time. This can mean adding the extra time for an out-of-the-money option to get into the money, a feature that’s priced into the original option contract.

Extendible options can be holder-extendible, meaning the purchaser can choose to extend their options. They can also be writer-extendible, meaning that the issuer has the right to extend the expiration date of the options contracts, if they so choose.

9. Lookback Options

Lookback options differ from most options because they do not come with a specified exercise price. Instead, an owner of a lookback option can choose the most favorable strike price from the prices at which the underlying asset has traded at throughout the duration of the option contract.

10. Spread Options

Unlike a traditional option, where the payoff depends on the difference between the contract’s strike price and the spot price of the underlying asset when the investor exercises the contract, a spread option pays an investor based on the price difference between multiple assets. The butterfly spread, which involves four separate options, is one example of a spread option.

11. Range Options

For highly volatile assets, some investors choose to use range options, because their payout is based on the size of the difference between the highest and lowest prices at which the underlying asset trades during the life of the range options contract.

Pros and Cons of Exotic Options

There are benefits and drawbacks to using exotic options.

Pros

•   Some exotic options have lower premiums than more flexible American options contracts.

•   Investors can select and customize exotic options to fit very complex and precise strategies.

•   With exotic options, investors can fine-tune the risk exposure of their portfolio.

•   Investors can use exotic options to find opportunities in unique market conditions.

Cons

•   Many exotic options come with higher costs, and less flexibility than traditional contracts.

•   There are no exotic options that guarantee a profit.

•   Because of their unique structures, exotic options sometimes react to market moves in unexpected ways.

•   The complex rules mean that exotic options have a higher risk of ultimately becoming worthless.



💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

The Takeaway

Exotic options are complex financial instruments that allow investors to make bets on the price of an asset without owning that asset itself. Unlike traditional options, exotic options include customizable features that investors can use to pursue a specific options trading strategy.

As many investors know, trading options — of all types — is relatively advanced, and requires a good amount of background knowledge and understanding of intricate financial assets. For that reason, it may be a good idea to speak with a financial professional before diving into options trading.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/Pekic

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Probability of Member receiving $1,000 is a probability of 0.028%.

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Aug
11
2023
Contango Vs. Backwardation: What's the Difference?

Contango vs Backwardation: What’s the Difference?

By | Growing Wealth, invest, Investing | Comments Off on Contango vs Backwardation: What’s the Difference?

Contango and backwardation are two ways to characterize and understand the state of the commodities or cryptocurrency futures markets, based on the relationship between spot and future prices.

In short, contango is a market in which futures trade at spot prices that are higher than the expected future spot price. But a contango market is not the same thing as a normal futures curve, though it is often mistaken for one. Normal backwardation, on the other hand, is a market where futures trade at a price that’s lower than the expected future spot price.

Futures and Derivatives

It’s important to have an understanding of both futures and derivatives to fully understand the difference between contango and backwardation.

Futures, Explained

Futures contracts, or futures, consist of legal agreements to buy or sell a security, commodity or asset at a set time in the future, for a predetermined price. One feature for both buyers and sellers of futures is that they can execute the contract no matter what current market price of the underlying asset when the contract expires.

Companies use futures contracts to hedge their risk of massive shifts in commodities prices, and investors who believe that the underlying security will go up or go down by a certain amount of time over a fixed period of time. The buyer of a futures contract enters a legal agreement to buy the underlying asset at the contract’s expiration date. The seller, on the other hand, agrees to deliver the underlying security at the agreed-upon price, when the contract expires.


💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

Derivatives, Explained

A derivative refers to any financial security whose value rises and falls based on the value of another underlying asset, such as a security or commodity. That includes securities such as futures, options, and swaps. The most common assets upon which derivatives are based include securities like stocks and bonds, commodities like oil or other raw materials, but they may also reflect currencies and interest rates.

Recommended: Derivatives Trading 101: What are Derivatives and How Do They Work?

The Futures Curve

When writing futures contracts for a given asset, the futures seller will place different prices on that commodity at different points in the future. While the base price of a futures contract is determined by adding the cost of carrying the underlying asset to its spot price, it also includes an element of prediction. People buy more oil in the winter to buy their homes, for example, so oil investors may predict that oil will be in higher demand — and thus cost more — in January than it will in May.

By comparing the prices within futures contracts for the same underlying asset at different points in the future, the dollar amounts form a curve.

Normal Futures Curve vs Inverted Futures Curve

In a normal futures curve, the prices assigned to the underlying asset of futures contracts goes up over time. In the example of oil, a normal futures curve will be one in which a barrel of oil is priced at $50 for a contract expiring in 30 days; $55 for a contract expiring in 60 days; $60 for a contract expiring in 90 days, and $65 for a contract expiring in 120 days.

A normal futures curve embodies an expectation that the price of the asset underlying the futures contracts — such as oil, soybeans, a stock, or a bond — will rise over time. An inverted futures curve assumes just the opposite.

To go back to the example of oil, in an inverted futures curve, a barrel of oil is priced at $50 for a contract expiring in 30 days; $45 for a contract expiring in 60 days; $40 for a contract expiring in 90 days, and $35 for a contract expiring in 120 days.

The futures curve is used by investors, policymakers and corporate treasurers as an indicator of popular sentiment toward the underlying asset. And the prices of those futures contracts can represent the market’s combined best guess about the prices of those assets.

The spot price of the asset, on the other hand, the price at which it’s currently trading. It’s the relationship between the spot price and the prices on the futures curve that determine if the futures market is in a state of backwardation or contango.

What Is Backwardation?

When an asset is trading at spot prices that are higher than the prices of that asset as reflected in the futures contracts maturing in the coming months, it’s called backwardation.

It can happen for a number of reasons, but most commonly occurs because of an unexpectedly higher demand for the underlying asset, especially in cases of a shortage in the spot market. Sometimes backwardation is caused by a manipulation of a commodity’s supply by a country or organization. Decisions by the Organization of Petroleum Exporting Countries (OPEC), for example, could create oil backwardation.

When backwardation occurs in futures markets, traders may try to make a profit by short-selling the underlying asset, while buying futures contracts that promise delivery at the lower prices. That trading drives the spot price down, until it matches the futures price.

What Is Contango?

Contango, on the other hand, is a situation where the spot price of an asset is lower than those offered in the futures contracts. In an oil contango market, for example, the spot price of the oil would rise to match that of the futures contracts at expiration. In contango, often associated with a normal futures curve, investors agree to pay more for a commodity in the future.

Backwardation vs Contango for Investors

Contango and backwardation can occur in any commodities market, including oil, precious metals, or agricultural products. Investors can find different opportunities and investment risks when investing in commodities in both backwardation and contango.

Recommended: Investing in Precious Metals

In backwardation, short-term traders who practice arbitrage can make money by short-selling the underlying assets, while buying futures contracts until the difference between the spot and futures prices disappears.

But investors can also lose money from backwardation in situations where the futures prices keep falling while the expected spot price remains the same. And investors hoping to benefit from backwardation caused by commodity shortage may wind up on the wrong side of their trades if new suppliers appear.

For investors, contango mostly poses a risk for investors who own commodity exchange-traded funds (ETFs) that invest in futures contracts. During periods of contango, investors can, however, avoid those losses by purchasing ETFs that hold the actual commodities themselves, rather than futures contracts.


💡 Quick Tip: If you’re an experienced investor and bullish about a stock, buying call options (rather than the stock itself) can allow you to take the same position, with less cash outlay. It is possible to lose money trading options, if the price moves against you.

The Takeaway

Contango and backwardation are two terms that describe the direction futures markets are headed. Knowing the difference between these two terms can help institutional and retail investors make the strategic choices when investing in a wide range of derivatives markets.

These are fairly high-level terms, and may be used as a part of an advanced trading strategy. If investors don’t feel comfortable investing in derivatives or futures contracts – or similar securities — it may be best to consult with a financial professional to get a better sense of if they fit into your strategy.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/LumiNola

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Probability of Member receiving $1,000 is a probability of 0.028%.

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Aug
11
2023
Implied Volatility: What It Is & What It's Used For

Implied Volatility: What It Is & What It’s Used for

By | Growing Wealth, invest, Investing | Comments Off on Implied Volatility: What It Is & What It’s Used for

Implied volatility (IV) is a metric that describes the market’s expectation of future movement in the price of a security. Implied volatility, also known by the symbol σ (sigma), employs a set of predictive factors to forecast the future changes of a security’s price.

Investors sometimes use implied volatility as a way to understand the level of market risk they face. They calculate the implied volatility of a security using either the Black-Scholes model or the Binomial model.

What Is Volatility?

Volatility, as it relates to investments, is the pace at which the market price of a security moves up or down during a given period. During times of high volatility, prices experience frequent, large swings.


💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

What Is Implied Volatility?

Implied volatility is, in essence, a prediction, based on probability. While it shapes the price of an option, it does not guarantee that the price activity of the underlying security will indeed be as volatile, or as stable, as the expectation embedded in its implied volatility. While implied volatility isn’t a window onto the future, it does often correlate with the broader opinion that the market holds regarding a given security.

To express implied volatility, investors typically use a percentage that shows the rate of standard deviation over a particular time period. As a measure of market risk, investors typically see the highest implied volatility during downward-trending or bearish markets, when they expect equity prices to go down.

During bull markets on the other hand, investors implied volatility tends to go down as more investors believe equity prices will rise. That said, as a metric, implied volatility doesn’t predict the direction of the price swings, only that the prices are likely to swing.

How Implied Volatility Affects Options

So how does implied volatility affect options? When determining the value of an options contract, implied volatility is a major factor. Options implied volatility can also help options traders decide whether and when to exercise their option.

An investor buying options contracts has the right, but not the obligation, to buy or sell a particular asset at an agreed-upon price during a specified time period. Because IV options forecast the size of the price change investors expect a security to experience in a specific time span, it directly affects the price an investor pays for an option. It would not help them determine whether they want a call or a put option.

It can also help investors determine whether they want to charge or pay an options premium for a security. Options on underlying securities that have high implied volatility come with higher premiums, while options on securities with lower implied volatility command lower premiums.

Recommended: Popular Options Trading Terminology to Know

Implied Volatility and Other Financial Products

Implied volatility impacts the prices of financial instruments other than options. One such instrument is the interest rate cap, a product aimed at limiting the increases in interest charged by variable-rate credit products.

For example, homeowners might purchase an interest rate cap to limit the risks associated with their variable-rate mortgages and adjustable-rate mortgage (ARM) loans. Implied volatility is a major factor in the prices that people pay for those caps.

How Is Implied Volatility Calculated?

There are two implied volatility formulas that investors typically use.

Black-Scholes Model

One of the most widely used methods of calculating implied volatility is the Black-Scholes Model. Sometimes known as the Black-Scholes-Merton model, the Black-Scholes model is named for three economists who developed the model in 1973.

It is a complex mathematical equation investors use as a way of projecting the price changes over time for financial instruments, including stocks, futures contracts, and options contracts. Investors use the Black-Scholes Model to forecast different securities and financial derivatives. When used to price options, it uses the following factors:

•   Current stock price

•   Options contract strike price

•   Amount of time remaining until the option expires

•   Risk-free interest rates

The Black-Scholes formula takes those known factors and effectively back-solves for the value of volatility.

The Black-Scholes Model offers a quick way to calculate European-style options, which can only be exercised at their expiration date, but the formula is less useful to accurately calculating American options, since it only considers the price at an option’s expiration date. With American options, the owner may exercise at any time up to and including the expiration day.

Recommended: The Black-Scholes Model, Explained

Binomial Model

Many investors consider the binomial option pricing model more intuitive than the Black-Scholes model. It also represents a more effective way of calculating the implied volatility of U.S. options, which can be exercised at any point before their expiration date.

Invented in 1979, the binomial model uses the very simple assumption that at any moment, the price of a security will either go up or down.

As a method for calculating the implied volatility of an options contract, the binomial pricing model uses the same basic data inputs as Black-Scholes, along with the ability to update the equation as new information arises. In comparison with other models, the binomial option pricing model is very simple at first, but becomes extremely complex as it accounts for multiple time periods.

By using the binomial model with multiple periods of time, a trader can use an implied volatility chart to visualize the changes in implied volatility of the underlying asset over time, and evaluate the option at each point in time. It also allows the trader to update those multi-period equations based on each day’s price movements, and new market news emerges.

The calculations involved in the binomial model can take a long time to complete, which makes it difficult for short-term traders to utilize.


💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

What Affects Implied Volatility?

The markets fluctuate, and so does the implied volatility of any security. As the price of a security rises, that can change its implied volatility, which translates to changes in the premium it costs to buy an option.

Another factor that changes the implied volatility priced into an option is the time left until the option expires. An option with a relatively near expiration date will have lower implied volatility than one with a longer duration. And as an options contract grows closer to its expiration, the implied volatility of that option tends to fall.

Implied Volatility Pros and Cons

There are both benefits and drawbacks to be aware of when using implied volatility to evaluate a security.

Pros

•   Implied volatility can help an investor quantify the market sentiment around a given security.

•   Implied volatility can estimate the size of the price movement that a particular asset may experience.

•   During periods of high volatility, implied volatility can help investors choose safer sectors or products.

Cons

•   Implied volatility cannot predict the future.

•   Implied volatility does not indicate the direction of the price movement a security is likely to experience.

•   Implied volatility does not factor in or reflect the fundamentals of the underlying security, but is based entirely on the security’s price.

•   Implied volatility does not account for unexpected adverse events that can affect the security, its price and its implied volatility in the future.

The Takeaway

Investors use implied volatility to predict the changes in security prices that increase the odds of success. It is a useful indicator but it has limitations, so investors may want to use it in connection with other types of analysis.

Volatility is a fairly high-level concept as it relates to the markets, and given that there are different types of volatility, it may be beyond most investors’ ability to properly use as a part of a larger strategy. That said, having a basic understanding of implied volatility can be useful for nearly all investors.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/nortonrsx

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Probability of Member receiving $1,000 is a probability of 0.028%.

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Aug
11
2023
What is a Death Cross Pattern in Stocks? How Do They Form?

What Is a Death Cross Pattern in Stocks? How Do They Form?

By | Growing Wealth, invest, Investing | Comments Off on What Is a Death Cross Pattern in Stocks? How Do They Form?

A death cross is the X-shape created when a stock’s or index’s short-term moving average descends below the long-term moving average, possibly signaling a sell-off. The death cross typically shows up on a technical chart when the 50-day simple moving average (SMA) of a stock or index peaks, drops, and then crosses below the 200-day moving average.

Because the 50-day SMA is more of a short-term indicator, it’s considered to be a more accurate indicator of potential volatility ahead than the 200-day SMA, which has averaged in 200 days worth of prices. That said, both the 50-day moving average and the 200-day are, by definition, lagging indicators. Meaning: They only capture what has already happened. Still, some death crosses have appeared to forecast major recessions — although they can also send false signals.

What Is a Death Cross, Exactly?

A death cross is based on a technical analysis of a security’s price. The short-term average dropping below the long-term average to create an X-shape is the “cross”; the “death” part of the name refers to the ominous signal that such a crossing may send for individual securities or overall markets.

A death cross tends to form over the course of three separate phases. In the first phase, the rising value of a security reaches its peak as the momentum dies down, and sellers begin to outnumber buyers. That brings on the second phase, in which the price of the security begins to decline to the point where the actual death cross occurs.

That’s typically marked as being when the security’s 50-day moving average dips under the 200-day moving average.
That crossing alerts the broader market to a potential bearish, long-term trend, which brings about the third and final phase of the death cross. In this phase, the stock may continue to lose value over a longer period.

If the dip following the cross is short-lived, and the stock’s short-term moving average moves back up over its long-term moving average, then the death cross is usually considered to be a false signal.


💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

What Does the Death Cross Tell Investors?

The death cross has helped predict some of some of the worst bear markets of the past 100 years: e.g., in 1929, 1938, 1974, and 2008. Nonetheless, because it’s a lagging indicator, meaning that it only reveals a stock’s past performance, it’s not 100% reliable.

Another criticism of the death cross is that the pattern sometimes won’t show up until a security’s price has fallen well below its peak. In order to alter a death cross calculation to see the downtrend a little sooner, some investors say that a death cross occurs when the security’s trading price (not its short-term moving average), falls under its 200-day moving average.

For experienced traders, investors, and analysts, a death cross pattern for a stock is most meaningful when combined with, and confirmed by, other technical indicators.

When interpreting the seriousness of a death cross, experienced investors will often look at a stock’s trading volume. Higher trading volumes during a death cross tend to reveal that more investors are selling into the death cross, and thus buying into the downward trend of the stock.

Investors will also look to technical momentum indicators to see how seriously to take a death cross. One of the most popular of these is the moving average convergence divergence (MACD), which is based on the moving averages of 15, 20, 30, 50, 100, and 200 days, and is designed to give investors a clearer idea of where a stock is trading than one that’s updated second by second.

Death Cross vs Golden Cross: Main Differences

The opposite of a death cross is known as a golden cross. The golden cross indicator is when the 50-day moving average of a particular security moves higher than its 200-day moving average.

While the golden cross is broadly considered a signal of a bull market, it has some of the same characteristics as the death cross in that it’s essentially a lagging indicator. Experienced investors use the golden cross in conjunction with other technical indicators such as trading volume and MACD.

Is a Death Cross a Reliable Indicator?

Historically, the death cross indicator has an impressive track record as a barometer of the broader stock market, especially when it comes to severe downturns, as noted above.

The Dow Jones Industrial Average (DJIA) went through a death cross shortly before the crash of 1929. More recently, the S&P 500 Index underwent a death cross in May of 2008 – four months before the 2008 crash. In both instances, investors who stayed in the market faced extreme losses. But the Dow also experienced a death cross in March of 2020. And the markets quickly rebounded, and rose to new heights.

The fact is that broad-market death crosses happen frequently. Prior to 2020, the Dow has gone through five death crosses since 2010, and 46 death crosses since 1950. Yet the index has only entered a bear market 11 times since the 1950s. A death cross doesn’t necessarily bring significant losses, either.

Even more noteworthy is that the Dow continued falling after a death cross only 52% of the time since 1950. And when it did keep falling, its median decline after a month was only 0.9%.

For short-term traders, the death cross has less value than it does for investors with longer-term outlooks. As an indicator, the death cross – especially one that’s market-wide – can be especially valuable for long-term investors who hope to lock in their gains before a bear market begins.

How to Trade a Death Cross

The death cross is a significant indicator for some investors. But it’s important to remember that it only shows past trends. As an investor, it’s equally important to use the death cross in conjunction with other indicators such as the MACD and trading volume, as well as other news and information related to the security you’re investing in.


💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

The Takeaway

Although the ominous-sounding death cross stock pattern is valued by some analysts and investors as a way to foretell a downturn in a certain security or even the broader market, it’s really not that reliable. The main elements of the death cross — a stock’s short-term moving average and long-term moving average — are lagging indicators that may or may not predict a bearish turn of events.

The typical investor may not use or even look for death crosses as a part of their strategy. But knowing, on a basic level, what the term refers to, and why it may be important to the markets, is a good idea.

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SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Aug
11
2023
Lidar Stocks: What Are They & How Do You Pick the Best Ones?

Lidar Stocks: What Are They & How Do You Pick the Best Ones?

By | Growing Wealth, invest, Investing | Comments Off on Lidar Stocks: What Are They & How Do You Pick the Best Ones?

Many people associate “Lidar” with the sensors that enable self-driving cars — but there are a growing number of applications for this technology that can offer attractive new opportunities for investors. New developments in self-driving cars and other smart products are driving demand for Lidar technology, which is in turn helping to spur the growth of Lidar companies innovating in this space.

What Is Lidar? How Is it Used?

Lidar is short for “light detection and ranging,” and Lidar works by using short bursts of light from lasers to create a 3-D rendering of an object or environment.

Devices equipped with Lidar detect nearby objects, and process massive amounts of data to determine information such as their size, direction and speed of movement — which is why Lidar has become a core technology in the sensors that may one day allow self-driving cars to operate safely.

What many people don’t know is that Lidar is also at work in the newest smartphones and other automated devices like robot vacuum cleaners, which use Lidar to scan the environment and maneuver through a room.

Lidar is also widely used for measurement and imaging in an array of scientific disciplines, including oceanography, archaeology, forestry, seismology, robotics and atmospheric physics. For that reason, some lidar technology stocks attract investor interest.


💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

The Advantages of Lidar

Lidar offers several advantages over similar technologies, such as radar, because light has a shorter wavelength than radio waves. By sending out repeated laser bursts, Lidar can offer a clearer picture of a given target.

For example, the Lidar sensors on some smartphones can give users almost instantaneous estimates of the size, shape and distance of an object, a capability that has enabled better experiences of augmented reality.

Also, as the Internet of Things (IoT), an element of Web 3.0, moves toward increasingly autonomous and interconnected machines, those devices will likely need sophisticated sensors to operate safely and effectively, which is another reason why Lidar companies and Lidar stocks are catching the eye of investors large and small.

Some Lidar Drawbacks

That said, investors considering Lidar technology stocks should be aware of some of the drawbacks as these may present some investment risks. Although Lidar technology can be highly sophisticated, critics note that some Lidar systems can lag in a more dynamic environment (e.g. driving in traffic), where a swift analysis of driving conditions is critical to safety.

Another drawback is that some Lidar sensors may weigh all data points equally in a given environment, and fail to take into account a more present danger like a certain obstacle or bad weather. For example: Lidar functionality has also been compromised by rainy or cloudy conditions, or very bright sun — as any of these can interfere with the light reflection and refraction that’s fundamental to the technology.

Lidar Stocks to Watch

Given the growth of the industry, and industries utilizing Lidar technology, there are numerous lidar stocks on the market. While investors will likely come up with a list by engaging in a quick internet search, it’s important to remember that Lidar is a developing technology, and that all stocks have associated risks. In short: Be sure to do your homework before investing in Lidar stocks.

Evaluating Potential Investment Risks With Lidar Stocks

Lidar has been finding its ways into the products people use on a daily basis, and it holds great promise as an enabler for many technologies in many different fields. As such, investors may find investment opportunities through one or several public Lidar companies.

But investing in Lidar stocks comes with some risks. One risk factor investors should consider: a single version of Lidar technology might emerge as a frontrunner, elevating one patent-holding company to prominence and relegating others to the status of also-rans. On the flip side, there is also the risk that one company’s technology might be adopted, but not widely.

And while Lidar is seen by many as an essential technology in self-driving cars, there is some debate on this point, with reports indicating that some automakers are exploring other types of sensors and networks to create safe, viable autonomous vehicles.


💡 Quick Tip: Are self directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

The Takeaway

Lidar technology and sensors are well-entrenched in the autonomous car market, and now a growing number of companies are finding innovative ways to use this laser-driven technology to make advancements in other industries — like oceanography, seismology, robotics and more.

While the expanding array of players in the Lidar space may be contributing to a sense of excitement about what the future of Lidar may hold, competing companies and technologies also indicate that this is a sector that’s still in flux, and there is much for investors to weigh when it comes to choosing the best Lidar stocks.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/Drazen_

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Probability of Member receiving $1,000 is a probability of 0.028%.

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